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Why The VIX Is Your Friend

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Wow, the level of financial market volatility this last week has been dizzying and the mass media has been taking full advantage.  No sooner do you have your first cup of coffee and CNBC is sending out headlines like:  futures indicate a stock market opening down 1,000 points! Yikes that is pretty scary stuff no matter if you are an active investor or just a casual observer.

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We have all come to view volatility as something to be avoided whenever possible.  This may be conventional wisdom, but conventional wisdom produces conventional results: in other words, ordinary.

Volatility can be your best friend and a great way to hedge your investments.  There are just two important things to remember.  First, very seldom does anyone make money reacting to volatility.  Once a price correction like the past week begins, it is too late.  You absolutely must be a contrary thinker.

Common sense says that when the headline reads “Dow breaks 26,000 marking a new record close” that should send out all kinds of warning signals.  There is no need for sophisticated analytical software.  The lesson of the recent past: when so many new record highs have been reached without a correction creates complacency. This is the enemy.

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How To Benefit From Volatility

The next thing to figure out is how to benefit from volatility.  There is no single answer because the market is loaded with choices.  If you are an adrenaline junky and actively trading the options market offers endless possibilities.  The mere presence of volatility creates outsized premiums on both the call and put side of the market.

Options allow you to create any scenario of the future your imagination can concoct.  If you are concerned that a major market correction is in the offing, you can load up on S&P 500 Index Puts for a simple example.  

But here is the trick.  Options typically trade at a premium and have a limited life; normally a few months or less.  Your risk is the need to be right on the direction, magnitude and timing of a market correction.  If you are off on your guesstimates, you can lose money as the price premium slowly evaporates over time.

Consider The VIX  

Successful option investors are a special breed that are blessed with analytical and mathematical skills that make places like the Chicago Board of Exchange a natural playground.  The rest of us are more interested in protecting our investments during periods of market turmoil. We want simplicity; let someone else do the math for us.

This is why I am constantly drawn to the VIX.  Here is a complex index where all the calculations are done by others and expressed in a single number.  You can buy it, hold it for as long as you want and sell it quickly when it has served its purpose.

The Benefits of Fear

The VIX is commonly call the fear index because it measures investor attitudes over the coming 30 days.  It is calculated and disseminated in real-time by the CBOE.  According the the official definition, the VIX Index price is a weighted blend of prices for a range of options on the S&P 500 Index.

Owning the VIX is like having and options expert at your fingertips.  Here is why.  The VIX is calculated as the square root of the par variance swap rate for the next 30 days.  This mathematical gobbly gook confuses many people and I have seen more than one investor reject the VIX because that wanted to understand the precise formula.

A Solid Correlation

The most important thing to remember is the VIX correlates inversely with the S&P 500.  This is another way of saying that when the major market averages fall people get nervous.  These nervous attitudes become expressed in the whole series of S&P 500 Futures contracts over the next 30 days.  The more these futures fall, the higher goes the price of the VIX.

The inverse correlation is well documented in the 10 year chart that goes back to the financial crisis of 2008.  At that tumultuous time the VIX hit an all time high of 59.  The last 5 years of building investor complacency has left the VIX languishing most days between 10-15.  There had been nary a mention of the VIX in the financial press until recent days.  During this most time, the VIX shot up from 12 to 50 in just two days.  Remember, that is not far from the all time high during the financial panic of 2008.

Goes Both Ways

The VIX is also a good indicator of when markets are oversold.  So the fact that the Index was driven to near record levels may be telling us the worst is be over for the stock market correction.  If so the VIX served its purpose over that last week but we suggest keeping a close eye on this little misunderstood gem of a hedging vehicle.  Once investor fear is awakened, it tends to hang around.

Featured image courtesy of Shutterstock. 

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 24 rated postsJames Waggoner is a veteran Wall Street analyst and hedge fund manager who has spent the past few years researching the fintech possibilities of cryptocurrencies. He has a special passion for writing about the future of crypto.




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Analysis

Daily Analysis: Oil Extends Rally as Nasdaq Leads Stocks Higher

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Friday Market Recap

Asset Current Value Daily Change
S&P 500 2749 1.38%
DAX 12,483 0.18%
WTI Crude Oil 63.58 1.29%
GOLD 1330.00 -0.16%
Bitcoin 10,14 -0.09%
EUR/USD 1.2295 -0.28%

US equities built up some bullish momentum towards the end of the week, ignoring the technical damage that the volatility-crash caused, and the major US indices rallied into the close today, squeezing the shorts. The Nasdaq, which led the rally as we expected, took out the key 6850 level in late trading and added another percent to, incredibly enough, finish only a hundred point of the all-time high.

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NASDAQ 100 Futures, 4-Hour Chart Analysis

Should the tech benchmark retest the high next week, it will be amid very strong negative divergences, but hey, those divergences have been building for months now. The rally in equities was boosted by the dip in Treasury yields, especially at the long end of the curve, while Amazon continued ot lead the charge, closing right at the historic $1500 per share level.

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Russell 2000 (Small Cap) Index, 4-Hour Chart Analysis

The advance in the Dow and the S&P 500 is much less convincing and with small caps also lagging the tech-behemoth juggernaut, we remain skeptical regarding the sustainability of the move. That said, if the broader indices stay above the key levels, we will be trading the long side in equities, even as from an investment standpoint, valuations are still way above acceptable.

Forex Markets and Commodities

The lackluster performance of European and Asian stocks adds to the negative divergences, especially as the Euro stopped appreciating against the Greenback, and that should be helping stocks of the old continent. Of course, the DAX and the EuroStoxx 50 could play catch-up next week, barring another surge in the common currency.

EUR/USD, 4-Hour Chart Analysis

The most-traded forex pair remains in a short-term downtrend, as it failed to recapture the previously broken rising trendline, and the commodity related risk-on currencies also remained under pressure. The Canadian Dollar did bounce back off yesterday’s 8-week lows, boosted by the much hihger than expected inflation release and the jump in the price of crude oil.

USD/CAD, 4-Hour Chart Analysis

Oil benefited from the positive shift in sentiment, while the Syrian situation, which took a backseat in the headlines, still supports the rally. The Japanese Yen and gold were stable amid the risk-rally and that adds to our suspicions regarding the upside potential form these levels.

Cryptocurrencies

The segment started out the day with a strong bounce that carried the major coins higher by around 10%, but given the recent steep short-term pullback, even that wasn’t enough to turn the tide, and the day ended with an (almost usual) sell-off after the US close. Despite the recent volatility, the overall picture is still encouraging, with most of the majors being safely above the crash lows, likely in a new bullish cycle that has the potential to last for several more weeks or even months.

While new all-time highs are it guaranteed following the 60-70% declines among the largest coins, but even without those, plenty of upside potential is left for investors. With that in mind, investors should hold on to their coins and even add to their holdings on the short-term dips like the current one.

ETH/USD, 4-Hour Chart Analysis

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Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Analysis

Technical Analysis: Majors Stage Rally but Strong Levels Still Ahead

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The cryptocurrency segment has recovered from a broad correction today in early trading, with the most valuable coins all turning into green during the session, despite the bearish start to the overnight session. With bottom-to-top gains of up to 15%, the rally helped in easing the worries of bulls, especially in the case of the relatively weaker coins.

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Bitcoin and most of the largest altcoins remained stable during the selloff, and BTC recaptured the $10,000 level quickly after trading as low as $9600 overnight. The initial rally topped out near $10,400, and the coin is trading back near the $10,000 level, as the bullish momentum faded away somewhat.

BTC/USD, 4-Hour Chart Analysis

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That said, we expect the uptrend to continue even if the correction could still carry Bitcoin lower. Further strong support is found between $9000 and $9200, while targets are ahead at $11,300, $13,000, and $14,250.

ETH/USD, 4-Hour Chart Analysis

Ethereum showed strength during the bounce again after yesterday, together with the early leaders of the rally, and although the coin dipped below the $845 level in the second half of the session, the signs remain positive for bulls. Support levels are now found at $780, $740, $625 and $575, while resistance is ahead near $910 and $1000.

(more…)

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Analysis

Pre-Market: Stocks Refuse to Fall Even as China Takes Over Key Insurer

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Although it should have been a very quiet week in China, thanks to the New Year celebrations, the recent surge in volatility and the plunge in equities didn’t pass without consequences in the key market. Just shortly after effectively shutting down the Chinese version of the Volatility Index (VIX) (presumably to calm the markets…), one of the main actors of the monstrous financial web, Anbang, of the country had to be taken over to avoid a systemic event and stop the “creative” financial engineering that involved criminal activity (the shadow of 2008).

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China will likely need many more duck-tapes like this one if it wants to stop the largest credit bubble in human history to collapse, but for now, the solution could work. Equity futures edged higher since yesterday’s volatile close, and as the major US indices are holding up well, not far off last Friday’s highs, our bearish short-term view might have to be revised.

Nasdaq 100 Futures, 4-Hour Chart Analysis

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As we discussed before, the long-term uptrend is intact, and we expect at least a re-test of the highs even if we are in a large-scale top formation, but we thought that the technical damage caused by the crash three weeks ago would require more healing.

We are not turning bullish just yet, but today’s session could finally decide if we the BTFD-crowd is strong enough to turn the tide after the choppy drift lower this week. We are still focusing on the Nasdaq, as the broader market seems to be following the lead of the tech benchmark, and a move 6850 (in the Nasdaq 100 futures, and still the 2735 level in the S&P) would be a very positive sign for bulls.

DAX Index, 4-Hour Chart Analysis

The German DAX index is also showing some tentative short-term relative strength although it remains almost 10% below its all-time high, and it remains a strong negative divergence to be monitored.

Forex Markets Quiet

EUR/USD, 4-Hour Chart Analysis

The main pairs are trading in a choppy narrow range today after the strong move in the Yen and the drop in the USD yesterday. US Treasury Yields are edging lower today, helping the calm in equities and currencies, but on a bearish note, commodity currencies failed to rebound so far, and they were providing good signals since the crash. Day-traders should note that the Canadian Dollar will likely be very active again, with the Canadian CPI report coming out pre-market.

To sum the outlook up, we are still leaning on the risk-off side here regarding the short-term outlook, but we wouldn’t bet the farm on that, as there are mixed signals before the weekend.

Featured image from Shutterstock

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.7 stars on average, based on 115 rated postsTrader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.




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